According to the White House, the American Jobs Plan, President Biden’s proposed infrastructure bill, “will create millions of good jobs.” The president proposes to fund this plan by raising the corporate income tax rate from 21% to 28% and increasing the minimum tax on U.S. multinational corporations. The proposal also includes plans to eliminate a variety of loopholes and tax preferences for corporations.
Although the administration argues that the increase in the corporate income tax rate will be paid by wealthy corporate stockholders, a substantial share will ultimately be paid by consumers and workers. Raising the U.S. corporate tax rate so that it is among the highest in the world will discourage corporations from investing in the United States. If, as a result, corporate employees have less capital to work with, they will be less productive, and companies may hire fewer workers and pay them less.
True, the administration should have a plan to pay for the additional federal government spending resulting from the American Jobs Plan. It has already added $1.9 trillion to the federal debt with the American Rescue Plan, so that as a share of GDP, the projected government deficit for 2021 is the second largest it has been since 1945. But increases in the corporate income tax rate are not a good way to pay for infrastructure. If the administration really wants to help workers rather than risking higher unemployment, it should instead consider increasing other taxes—especially user taxes (such as airline ticket taxes to pay for airport improvements)—and putting forward a less ambitious spending proposal.
Raising Corporate Tax Rates Is Counterproductive
Increases in corporate income taxes reduce economic growth more than comparable increases in personal income taxes, consumption taxes or property taxes. That is because corporate income taxes discourage investment in capital, such as factories and equipment, which leads to lower total factor productivity growth and less entrepreneurship. The decline in private investment offsets the increased investment funded by the government, so that the net effect could actually be less overall investment and therefore less infrastructure.
Increasing the federal tax rate to 28% will result in the average combined federal and state corporate tax rate rising to 32.34%, the highest combined tax rate of any high-income country. This will discourage foreign direct investment in the U.S. while encouraging U.S. firms to invest more overseas in countries with lower tax rates.
Higher corporate tax rates also lead to tax inversions—corporations moving their headquarters to other countries. Fewer companies are likely to incorporate in the U.S. if tax rates are higher. Biden’s proposal includes anti-inversion regulations, so whether inversions increase in response to the higher tax rates should depend on whether the anti-inversion regulations are in the final bill and whether companies can find ways around those regulations.
Workers and Consumers Pay the Cost of Corporate Tax Hikes
The Congressional Budget Office estimates that 25% of the cost of corporate income taxes is ultimately paid by labor through lower wages: With higher taxes, corporations invest less, so their employees are less productive and are paid less. Similarly, a recent NBER working paper finds that 31% of the cost of corporate incomes taxes falls on consumers and 38% falls on workers, with only the remaining 31% falling on shareholders. Many other empirical studies find that workers bear at least half of the cost of tax increases in the form of lower wages and fewer jobs. The Tax Foundation estimates that the corporate tax rate increase proposed in the American Jobs Plan will result in 59,000 fewer jobs and a 0.7% average wage reduction. Further, it will reduce wages for workers of all income levels.
Contrary to these findings, the Tax Policy Center maintains that only about 20% of the cost of increasing the corporate income tax will be borne by workers, with most of the rest borne by wealthy corporate shareholders. But this argument is based on two mistaken assumptions: (1) that a higher tax rate will not result in significantly less investment, and (2) that certain tax laws passed by the previous administration will be reenacted rather than phased out.
First, the Tax Policy Center claims that investment is relatively insensitive to the corporate income tax rate because the tax is mostly paid out of excess profit rather than out of normal profit, which is the minimum amount firms expect to earn to justify an investment project. Excess profit is any earnings above normal profit. According to a 2016 study by staff members in the Treasury’s Office of Tax Analysis, excess profits account for 75% of the corporate tax base. But research by Stephen Entin of the Tax Foundation suggests that excess profits may be closer to 25% of the corporate tax base. And even assuming the 75% estimate is correct, taxes on excess profits may still reduce the incentive to invest because those profits are a reward for companies taking extra risks or producing part of their output at below-average costs.
Second, the Tax Policy Center’s low estimate of the burden to workers and consumers assumes that certain current tax exemptions will continue into the future, when this is not necessarily the case. Specifically, the Trump administration’s Tax Cut and Jobs Act (TCJA) permits companies to subtract the expense of equipment investment from their taxes at the time the expense is incurred. Thus, they are not taxed on the normal profit from such investment. But this provision is temporary and is scheduled to be phased out beginning in 2022.
If Congress were to extend this provision of the TCJA, raising the corporate income tax rate might not have much of an impact on equipment investment. But it would still have a big effect on investment in structures, which constitute an estimated 31.4% of the private capital stock, more than twice as much as equipment. In other words, if this provision of the TCJA is preserved, then the proposed increase in the corporate income tax will cause less economic harm. But it will also likely raise less revenue for the government.
Look For Other Ways To Raise Revenue
The Tax Foundation projects that over 10 years the proposed increase in the corporate tax rate will result in a net increase of federal government revenue of $643.7 billion, after accounting for the expected reduction in investment and economic output and the associated reduction in individual and payroll tax revenue. Increased government revenue seems like a good thing; but when compared with the trillions of dollars the federal government will spend on the American Jobs Plan, the net effects will be a higher national debt and a reduction in economic growth.
Increased government spending ultimately must be paid for by raising taxes. All taxes reduce the incentives for individuals or companies to earn money, since higher earnings mean higher taxes. The corporate income tax, especially if the rate is high and the base is large, will significantly reduce investment and slow economic growth.
The best way for the federal government to boost infrastructure is to let the private sector or state and local governments fund most of it. Instead of increasing the corporate income tax rate, the federal government should fund any increase in its spending on infrastructure with user taxes, such as fuel taxes.